JOHANNESBURG, July 20 Annual growth in South
Africa's retail sales was flat in May and inflation quickened
more than expected in June, highlighting the dilemma the Reserve
Bank is facing in containing inflation without hurting an
already-weak recovery.

The Reserve Bank is largely expected to leave the repo rate
unchanged at 5.5 percent on Thursday, when the focus will be on
any clues policymakers give about when rates will start rising
from 30-year lows after 650 basis points worth of reductions
between December 2008 to the end of 2010.

So far, the market is divided on the timing of the monetary
tightening cycle, with 12 out of 21 analyst polled by Reuters
last week seeing interest rates starting to rise before
year-end. [nL6E7IF0ZS]

The central bank has previously said it will be vigilant on
any signs of inflation risks emanating from demand and will not
hesitate to tighten policy.

But, it is loathe to tighten monetary policy just on food
and fuel prices alone, which have been the main drivers of
inflation that have helped to raise it from 5-year lows in
September last year. [ID:nLDE75K0EI]

Statistics South Africa on Wednesday said retail sales
growth was flat on an annual basis in May while inflation rose
to a 15-month high of 5.0 percent year-on-year in June, mainly
due to food and fuel prices. [ID:nJ8E7HE003] [ID:nJ8E7HE004]

Government bonds extended gains after the retail sales data
as the market moved to position for sideways movement in rates
this year. [ID:nL6E7IK0LF]

The forward rate agreements have also pointed to softening
rate rise expectations, with the rate on the 4x7 contract
falling to 5.67 Wednesday from 5.84 in mid-June.

"I was expecting Q4, but I think Q1 is when a hike is going
to happen," said Colen Garrow, an economist at Brait, changing
his rates view after the retail sales data.

WEAK RECOVERY

Retail sales were the main driver of growth before the
recession in 2009. The recovery has been anaemic and the economy
is expected to grow by 3.4 percent this year, a fraction of the
7 percent the government has said is needed to reduce
unemployment from 25 percent of the labour force.

The government last year expanded the Reserve Bank's
mandate, asking it to also consider growth and employment in its
monetary policy decisions.

More than a million people have lost jobs since the
recession and with those that are unemployed hesitant to spend,
the Reserve Bank might be reluctant to tighten monetary policy
too soon.

The manufacturing sector, the second largest contributor to
GDP has also been sluggish with a bleak outlook given the global
economic slowdown. [ID:nLDE76B0WB]

"Latest statistics on local and international growth have
not been encouraging and we would therefore still expect the
Reserve Bank ... to delay its first hike until early 2012, as an
early interest rate increase would risk curbing the economic
recovery," said Nedbank in a note.

INFLATION RISE

The rise in inflation might not be that much of a surprise
to the Reserve Bank that sees inflation breaking outside its 3
to 6 percent target to peak at 6.3 percent in the first quarter
of 2012.

Administered prices, such as electricity prices and
municipal rates, are likely to add to inflationary pressures
over the next few months.

"Core inflation increased by 3.5 percent y/y from 3.2
percent, indicating that demand driven inflation is starting to
rise," said Investec in a note, calling for a rate increase in
the fourth quarter of this year.

"The SARB will monitor it closely to gauge underlying demand
push inflationary pressures," the company said, it could change
its view after the rate decision on Thursday.

The Reserve bank will likely to warn on double-digit wage
demands, which have led to strikes at some companies in the
mining, chemical industries. [ID:nL6E7IE1MA]

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